May 14, 2018
Our readers know that we like Pilbara Minerals (PLS) as a company and as an investment. Managing Director Ken Brinsden has done a great job progressing their Pilgangoora Lithium Project to date and is expecting to commence production later this year, with the first concentrate delivery expected by late Q22018. While we’ve had Ken on the site for a few interviews to hear his take on the investment landscape in the industry, we decided it was time we published our thoughts on the company as an investment.
Please note that we will forego covering the industry backdrop in this post, as our thoughts on the long term outlook for the industry has been well documented in other posts. So this analysis is a company specific extension of the work we’ve done on the industry.
Pilbara Minerals owns the Pilgangoora Lithium Tantalum Project in the Pilbara region of Western Australia. To bring the project online, the company has chosen to go with the two stage plan. At nameplate capacity, stage 1 can potentially produce 2Mtpa of spodumene ore, or ~320ktpa of 6% spodumene concentrate, and ~43ktpa LCE. Stage 2 will bring total production up to ~100ktpa LCE. Stage 1 is expected to commence production this year, while stage 2 is currently scheduled for late 2019, early 2020.
The projects boasts the characteristics shown in the table below:
To put these stats into perspective, we compare Pilbara to Nemaska Lithium and Kidman Resouces, two other high quality hard rock projects. Kidman is progressing the Mount Holland Lithium project via a 50/50 JV with SQM that currently boasts 7Mt of contained LCE and estimated cash operating costs of $205/t. Nemaska, in Quebec, Canada boasts approximately 1.5Mt of contained LCE and estimated cash operating costs of $257/t. Compared to the two, Pilbara has a lower grade for their project (1.27% vs closer to 1.5% for the other two), but sits between the two in terms of operating costs.
Both Nemaska and Kidman will look to become integrated producers of lithium. It’s tough to compare Pilbara on the basis of downstream lithium hydroxide or carbonate production costs as they are initially going to be focusing on selling concentrate. However, the 2021 projected cost curves below show how Nemaska is forecasted to be positioned vs other major producers and can give a rough idea of where Pilbara could be situated if they were to either commence downstream production or be acquired by a downstream producer looking to vertically integrate operations (more on that later). Most of our readers have learned by now that the conventional wisdom of brine is always cheaper than hard rock lithium production is not necessarily true, especially when looking at lithium hydroxide production. These graphics do a great job showing how the playing field evens out for hard rock producers as the world pushes toward lithium hydroxide for EV batteries.
Long story short, Pilbara has a strong, high quality project which should see low operating costs and a very long mine life. While this may not be as big of a deal for short term oriented investors, in the long run, the largest and lowest costs projects will be the ones that fare the best.
We’ve gotten to know Ken Brinsden, Managing Director of PLS, pretty well over the past year. He is a strong operator, with extensive mining and greenfield project development experience. He is also surrounded with a great team boasting extensive technical and corporate experience. Furthermore, with very strong offtakers/investors involved, there is ample quality experience management can tap to seek guidance should they ever need to do so.
Finally, we like the strategy that management has employed to bring the project online as quickly as possible. They recognized that in the current tight supply/demand market conditions, elevated pricing for raw materials can be taken advantage of by anyone that can bring new supply online as quickly as possible. And as long as pricing remains elevated, it’s not completely necessary to build out downstream production. Bringing the project online in 2018, and then using cash flows from operations to plan for and build out that downstream capacity would reduce the need to raise further debt or equity, while still establishing the company as a long term lithium producer.
If you don’t want to take our word for it that Pilbara has a top tier project on their hands, just take a look at some of their offtakers. Most of these agreements were secured before the downstream desperation for lithium supply really kicked into high gear, which lends further credence to the belief these companies have in PLS. In addition to supply agreements, all of the companies helped fund project capex by means of equity placements.
The above graphic does a great job breaking down the how much of the production can be taken by each company, so we won’t spend too much time on that. We will however take a second to talk about the offtakers themselves. While General Lithium and Great Wall Motors are certainly no slouches, but we’re particularly interested in Ganfeng and POSCO.
Ganfeng- Ganfeng has quickly become a force to be reckoned with in the lithium industry, a trend they hope to continue after raising an expected $1B in a Hong Kong IPO slated for later this year. The company has their roots in the whole spectrum of the lithium ion battery life cycle- from stakes in upstream projects, to offtake agreements with Pilbara and Lithium Americas, and R&D spending into solid state battery research. The company firmly believes that lithium will be a key metal in the future and is securing their stronghold in the industry.
POSCO- With most of the industry focused on China’s massive investments into battery production and consequent expected demand of lithium, PLS decided to add South Korean POSCO to their offtaker group. This deal is interesting because it not only shows long term interest in EVs outside of China, but the deal itself allows Pilbara to participate in downstream production through a 30% interest in a lithium hydroxide/lithium carbonate conversion plant beginning 2019. If PLS chooses to participate in the plant, POSCO would provide the capital by means of a convertible bond (convertible at Pilbara’s option).
Aside from being a major vote of confidence in the company and project, we think having the agreement from Ganfeng makes Pilbara really interesting from the perspective of a potential acquisition. Ganfeng has made it no secret that they are interested in doing further deals to secure their long term position in the lithium industry. Compounding that fact is their upcoming Hong Kong IPO that is expected to raise $1B.
Normally, with companies that have secured long term offtake agreements, we would look at that as a hindrance to potential deals. However, Ganfeng can receive 310kt of the expected 800-850kt (or 35-40%) of combined stage 1 & 2 production through agreements lasting at least 10 years. So if they were to make a bid for the whole company, they could fund the development of stage 2 operations on their own, and convert a large chunk of production themselves, while waiting for the other offtake agreements to roll off.
The logical argument here would be that Ganfeng doesn’t really need to do any deal right away, they can just wait until the offtake agreements expire and make a bid to control 100% of production from the project. While that is certainly true, acquiring Pilbara now would allow Ganfeng to get a jumpstart on establishing large scale integrated operations for the long term. Furthermore, lithium stocks have come down quite a bit from their highs recently, so they would also be getting a bargain price on the deal.
Since the company is not yet in production, valuing Pilbara via a DCF would rely on too many assumptions for our liking. So for our valuation, we’ve decided to keep it simple for readers to give them a quick, back of the envelope calculation. One of the reasons we like taking this approach is because our investment horizon in the lithium industry is long term, as we believe the story is in the very early innings. So we are striving to find high quality names with long term staying potential at a reasonable market price. Thus, this quick and dirty valuation allows us to quickly determine if the asset is undervalued, and whether it has growth potential. As the company commences and ramps up production, we’ll be building out a full model to keep track of the company.
Below is our calculation:
A few notes on the valuation:
- Pilbara’s fiscal year ends on June 30
- Figures are presented in thousands, except per tonne estimates
- Consensus EBITDA estimates are currently at $120m EBITDA for 2019. We expected a slightly slower ramp up.
- The stock is trading at ~14x our 2019 EBITDA. We use 15x EBITDA in our valuation because we expect the business to grow >20%/year on the top line with >50% EBITDA margins. While many have made the case for higher multiples when valuing some of the lithium projects, we don’t want to get carried away.
- As you can see in the figure above, over the next 5 years alone, there is tremendous potential for value creation for shareholders.
Before we wrap up, we wanted to take a second to discuss potential risks to our investment thesis. The obvious risk with any of the lithium companies is a delayed ramp up of EV penetration, causing a lithium oversupply environment to materialize. This would cause pricing to dip, and pressure margins. Furthermore, Pilbara’s lack of vertical integration in the long run could cause them problems in the long run. If they choose not to become an integrated producer of lithium products, their product will likely become commoditized at some point. Finally, it should be noted that the company has a long way to go before they reach expected nameplate capacity of 800-850ktpa of spodumene concentrate. So there is a lot of execution risk facing the company as well as the fact that the lithium market fundamentals can change before the company has a chance to even bring that supply online.
Disclaimer: We own shares of Pilbara Minerals. This is not investment advice, readers should do their own research prior to investing.